Lots of folks obsess about finding the lowest possible interest rate. And, we don’t disagree that finding the lowest rate is super important—it’s why our rates are 0.48 points lower than most of the mortgage industry on a typical single family home.
But the single biggest thing that keeps people from buying a home is the cash they’ve saved up. That’s because that cash not only needs to cover the down payment (3% minimum, but let’s say 5% as a more common scenario) but also the closing costs (which could be another 3%). So, if you want to buy a typical $400,000 home, you’ll likely need to have at least $32,000 in the bank.
Now, there’s a way you can jump forward in your buying timeline that can have a huge impact on your overall wealth creation: Lender credits.
We’re one of the only mortgage companies anywhere that shows lender credits on our website, but they can be a really helpful tool for new homebuyers getting started.
Basically, if you take a slightly higher interest rate than the “par rate” at the time—the lender actually pays you for the loan when you close. (Note the par rate is with 0 credits, and it’s a golf term because, you know, financial people came up with it. Technically there might not be a par rate because that’s not really how loan pricing works, but that’s a whole other discussion.)
So, let’s go back to that same scenario above—say you have good credit and want to buy a $400,000 home, but have only saved $30,000. Say you’re earning $125,000 per year, and you’re able to save 10% of your take-home pay (about $750 per month). To get to the $32,000 you’ll need at closing, that’ll take you another 3 months of saving—an entire season.
Or, you could take a slightly higher interest rate (say, 6.625% vs. 6.375%), which comes with a lender credit of $2,440. That’ll give you the power to buy 3 months earlier, start earning value on the home sooner (vs giving money away on rent, let’s say $1,700 per month on average), and the only added cost is $62 per month for the mortgage.
So to put it all in perspective:
| Buy Now with Lender Credit | |
| Added Monthly Payment (5 years) | -$3,720 ($62/mo) |
| Value of No Extra Rent Payments for 3 mo | +$5,100 |
| Added Home Value in 3 mo | +$5,000 |
| Total Benefit | $6,380 |
So, if you buy now with a little higher interest rate (versus waiting), in theory, you’ll be $6,380 ahead. Now, there’s a lot of assumptions baked into this assessment (e.g., if you buy in the spring, prices might be a bit higher because it’s more competitive than if you buy in the winter). And you’ll likely look to refinance anyway after 5 years or so (that’s why we didn’t run the math for a full 30 years—few people will keep a mortgage that long). But the point is that buying sooner is usually better than waiting. And a little hit on the interest rate isn’t the end of the world—in some cases it’s the right move.
How do lender credits work?
Say you get lender credits on a $400,000 loan. Your rate might go from 6% to 6.25% if you take $3,000 in lender credits. That means your monthly payment goes up a little, but you don’t need to pay that $3,000 right away.
Lender credits comparison
| Scenario | Without lender credits | With lender credits (e.g., $3,000 credit) |
| Loan amount | $400,000 | $400,000 |
| Interest rate | 6.00% | 6.25% |
| Monthly payment | $2,398 | $2,466 |
| Total interest paid | $367,457 | $380,566 |
| Closing costs | $10,000 | $7,000 |
| Lender credit applied | N/A | $3,000 |
| Cash needed at closing | $10,000 | $4,000 |
What are the drawbacks of lender credits?
The downside is that you’re trading a lower rate for higher monthly payments. Over time, this means paying more in interest which will bring up your payments in the long run (if you don’t refinance or sell, that is), so you have to decide if the immediate savings are worth the extra cost later.
Who do lender credits make sense for?
Lender credits can be a smart move for certain situations. This option is particularly beneficial if you’re planning to live in the home for a short period of time or if you’re expecting to refinance quickly (less than 5 years, for example). By taking the credit, you can keep more cash in your pocket upfront, which is useful if you don’t plan to hold onto the mortgage long enough for the higher interest rate to become a significant cost.
Example: If you’re only planning to stay in the home for a few years, the immediate savings from lender credits can outweigh the long-term costs associated with a higher interest rate.
As we mentioned above, they are also a great resource for buyers who would not have the funds for closing costs without the help of lender credits.
How are lender credits different from points?
Lender credits and mortgage points are basically two sides of the same coin. With mortgage points, you’re paying extra money upfront to get a lower interest rate. Think of it like prepaying interest—you’re spending more now to save on your monthly payments over time.
Lender credits, on the other hand, work the opposite way. You accept a higher interest rate in exchange for the lender covering some of your upfront costs. This means lower initial expenses, but your monthly payments will be higher.
Are lender credits taxable?
Nope, lender credits aren’t taxable. They’re just part of your mortgage terms to help with closing costs, not extra income.
Can I use lender credits for all types of closing costs?
You can use lender credits for most closing costs like appraisal fees and title insurance, but not for your down payment.
Conclusion
Whether lender credits are the right move really depends on your situation. If you’re short on cash for closing costs or don’t plan to stay in the home for a long time, lender credits could make sense. But if you have the funds and plan to stay put (and the interest rates are really low at the time you’re buying and you’ll want to hang on to that rate forever), paying points to lower your rate might be the better option. It’s all about balancing what you can handle now versus what you want to save later.
If you’re ready to start your journey to homeownership, get pre approved with Tomo Mortgage today.
